Mon, 09 Sep 2019 20:31:55 -0400WeeblySun, 01 Sep 2019 04:00:00 GMThttp://www.atiwealthpartners.com/blog/europe-or-youre-upBack in the USA! And for our first meal in Atlanta after two months, we had...Chinese. Which was delicious, but our fortune cookie said - no joke - “Don’t invest in the stock market. Invest in family instead.” Well played, China. Apparently we have progressed to the psyops portion of the trade war.

But let’s leave China to the side for the time being (until we get into what it means to have the world’s reserve currency) and stick with Europe for another month. Europe is a hot mess.

​Let’s start with Brexit. Boris Johnson is brilliant. Well, perhaps not. I mean, he kind of looks like he never outgrew his second year of boarding school where experimentation with sloppy hair and dress was all the rage, which admittedly taints our opinion. But he and/or his advisors (rumor has it Dominic Cummings is largely the brains behind the Brexit tactics) have played this beautifully.

This is not an endorsement of Brexit, merely an appreciation of political tactics. Though to be honest, from our desk an ocean away, Brexit doesn’t seem to be the terrible tragedy the Remain side claims. And given that the Conservative party (Boris Johnson) has gone from down 2 points in the polls to the Labour party to up 10 since he got selected prime minister (a time span of about two months), it seems the populace seems to agree. A populace that, remember, did vote to leave. Without even a faithless electoral college to muck things up!

(Sidebar: Good on the appeals court. America is not and never has been a populist democracy, it’s a representative democracy. Yes, the electoral college is super outdated and needs a change, and yes, finding out that your vote doesn’t really count for anything other than which political party gets to put up their slate of favorite contributors, oops, sorry, we mean electors, hurts, but just consider it another lesson in the State not actually caring about you.

What we’d like to see is to do away with the electors completely - keep the electoral “votes” as they are, just don’t have actual people casting them. California still gets 55, Georgia still gets 16, New Hampshire still gets 4, etc., but they get allocated via proportional representation based on the popular vote in that state. If California votes 61.7% for Clinton (which they did in 2016), then she gets 34 electoral votes and Trump gets 21. This has the benefit of using the existing electoral college system (which is still useful for protecting the smaller, less populated states as well as being easier from an overcoming-inertia standpoint) and the added benefit of making individual votes more meaningful - the Republicans in California or the Democrats in Texas/Georgia suddenly have something to actually contribute on a national level. Sidebar over.)

Back to Brexit. So Johnson goes to the Queen and gets her to agree to prorogue (suspend) parliament for a month, from September 14 - October 14. Kind of like how our Congress disappears for 6 weeks every summer (and 14 weeks from end July to middle October), regardless of any pressing issues or, you know, entitlement reform legislation that might be good to work on at some point.Johnson has promised a no-deal Brexit on October 30th (a date that came about as a result of many earlier negotiations between Britain and the EU), and now the opposition in Parliament has 30 fewer days to do anything about it. They have two weeks right now and then they’ll have just two weeks when Parliament starts up again. The thing is though, it doesn’t look like there’s a lot they can do. There are some legal attempts going on at the moment to try and stop Johnson, but proroguing is constitutionally legal. There’s talk of a no-confidence vote, but that would require a coalition government to form within the opposition (very unlikely, given the lack of leadership evident in the last 3 years of the Brexit mess) or result in a new election. But - twist! - the current government (Johnson) would be responsible for choosing the timing of the election, and he has already said it would be early November...after a no-deal Brexit.

Does Johnson actually want a no-deal Brexit? My guess would be no, which is part of the reason that he’s kept rebuffing Nigel Farage, but committing to one and putting it almost irrevocably in motion is the only thing that seems to give Britain any leverage for continued talks with the EU. So you’ll probably see a flurry of last-minute negotiations at the end of October and then a vote in Parliament on whatever gets cobbled together, with the specter of a no-deal Brexit on Halloween in the background. Trick or treat, indeed but it should be great watching from this side of the Atlantic. If you’ve never watched a Prime Minister’s question hour, do yourself a favor. They’re streamed live.

Also contributing to the dumpster fire that is Europe this summer, Italy’s government just collapsed. Not anarchy-and-street-protests collapse, but still. Here’s the Cliffs Notes version:

Italy was governed by a coalition between the Five Star Movement (M5S - a populist anti-establishment party started by former comedian Beppe Grillo) and the League (far-right party led by Matteo Salvini). The League is super popular right now, so Salvini withdrew his party from the coalition in the hopes of necessitating new elections and thereby winning a majority outright and becoming prime minister himself. So he went off to the beach to celebrate.

But, while Salvini was at the beach, M5S got together with the third largest party in government, the Democratic Party (PD) to try and form a new coalition government, avoid elections, and leave the League on the outside looking in. Except - twist! - you might remember the PD from Italian politics as one of the two main parties (the other being Berlusconi’s Forza Italia) for...pretty much forever, and in fact being the party in power when the M5S got started. As an anti-establishment group, remember.

So now you have basically antithetical political parties trying to make a coalition government. And when it falls apart (when, not if - this is Italy we’re talking about), you’ve got the far-right League waiting to come back into power. Which is important if you look down the road because Italy has the same problems Greece did. Bloated budgets, excess debt, and spending that exceeds EU mandates. Except Italy is a much bigger part of the EU. On economic terms, Greece is just under 2% of the Eurozone. Italy is 17%, and the third-largest of the 19 countries. So whereas Greece was forced to take the bitter pill of Austerity, Italy (especially a far-right-led Italy), will tell the EU to shove that pill like a suppository. So imagine what might happen in the markets, given that Greece managed to roil European markets for several years.

That graph is the last 10 years, 9/2009 to 9/2019. The orange line is the S&P 500, represented by SPY. It’s up 177% in 10 years. The blue line is the Eurozone, represented by EZU. It’s flat. Most of that flatness in the early years was because of the European Debt Crisis (ie, Greece). Italy will be a whole other can of worms.

Which brings up an interesting question vis-a-vis diversification: in the immortal words of Edwin Starr, “huh, what is it good for?” Stay tuned, because that’s where we’re headed with next month’s newsletter.

]]>Sat, 10 Aug 2019 04:00:00 GMThttp://www.atiwealthpartners.com/blog/back-to-schoolHappy Labor Day! Our summer school valuation series has wrapped up, just in time for the kids to go back to actual school. So let’s talk for a second about actual school. Specifically, college...or not.

College costs have gone up by about 2.5-3% a year for the last couple decades. That’s not bad in and of itself, but that is still about 8 times more than wages have gone up in the same time period, which leads to a problem with affordability.

So how does one go to college these days? With debt. Student loan debt in the US just passed $1.6 trillion, with a “t”. One in every four people under age 60 has student loan debt. 11% of them are currently in default, and that number could grow to as much as 40% in the next four years.

Student loans are particularly insidious for two reasons. First, they are among the only debts that can’t be discharged via bankruptcy - right up there with alimony and wrongful death payments. Second, instead of coming out of college with nothing and starting to build wealth and save money, you come out of college in debt, and every financial decision you take is influenced by that fact. Trying to network for the job you want? Too bad, you’ve got loan payments to make, go get whatever part-time job you can as soon as possible. Want to save up for your own place? Too bad, any excess income is going towards your student loans.

The Fed itself has said that every $1,000 of student loans equates to 2.5 months delay in a home purchase. The average student loan balance outstanding is about $37,000, so that makes it a 7+ year delay to buy a house.

College is one of those major life decisions that we make before we really have any idea what we’re doing. In retrospect, it doesn’t matter what degree you get, or really even what school you go to. What does matter, and matters every day, is how much it cost to go to that school or get that degree.

Consider: the average cost of for public in-state university (tuition plus room/board) is about $20k/year. Out-of-state is more like $36k/year. And a private university will run closer to $47k/year. That’s a lot of saving to do.

If you want to provide four years of private college education to your child so that she can start adult life debt-free, that’ll be roughly $1,000 per month from the time she’s born until the time she starts college. Eighteen years of $1,000 per month. Per child. The best way to save for college is a 529 plan. They’re administered by the state, offer tax deductions, and can be used down the road tax-free as long as the money goes towards education expenses. Georgia’s is called Path2College and offers up to $2,000 in deductions on your state income tax per person per beneficiary.

Or, consider a trade school. We as a country force feed the 4-year university ideal like we’re making foie gras. But there are viable alternatives out there. A trade school degree will take you two years and about $33k. Total, not per year. So you come out with skills, job prospects and little to no debt, which is a great place to start from.

Remember that show Dirty Jobs with Mike Rowe on the Discovery Channel? Most of those people he worked with owned their own companies and were millionaires. Just sayin’.

So fear not, that will be the end of the French. Language, anyway. The French themselves will be around for a while still. Despite themselves.

We managed to catch part of the Tour de France last week...and by “catch”, I mean there was a parade of...floats? But they weren’t really floats, they were decorated cars. One was a giant chicken. And they going at a solid 20mph, too, not your leisurely float pace. And people were harnessed in to the top/back/sides throwing knick-knacks at you as they whizzed by.

After accumulating a big pile of free loot, you wait and wait and then watch some cars go by with about three times the value of the car in bikes on the roof rack, and then BAM! The riders fly by and are gone in about 10 seconds. There wasn’t even time to look for the different jersey colors, though in hindsight we got a good picture of Peter Sagan and whoever was king of the mountains in Stage 15. There’s probably a nice, drawn-out analogy there between cycling strategy and investing...teamwork, pacing, endurance, and so forth. But that’s not where we’re going with this. No. Instead, we are going to take you on our own little tour of France, and try and discern what makes the French so, well...French.

France is the sixth-largest economy in the world (the US is first, and is about 7.5 Frances). It’s second in the Eurozone behind Germany, so is a major player on the European stage.

The first thing one notices when driving in France is that the lane discipline on highways is unbelievable. The second thing is that very little consideration is ever given to another driver, and for whatever reason that lane discipline disappears completely when not on highways.

There is a certain perception of the French among most Americans that seems to involve some degree of...haughtiness? Arrogance? That reputation doesn’t seem fully deserved, but there is a certain...entitlement, perhaps? And a definite sense of “not-my-problem”. It’s reminiscent of an entitlement we have witnessed growing back in the US as well, all of which got us to thinking - where does that attitude come from?

Is it all the wine?

Vineyards dot the French landscape like cornfields do in the US. Well, not quite to the same extent, but it sure feels that way. Corn, however, is useful. Here are things that are done with the corn in the US: Actual human food, food for other actual human food (livestock feed), industrial products (ethanol, recyclable plastics)...and it turns out that even a waste product from the corn separation process is used to grow penicillin.

Here are things that are done with the grapes in France: Wine. More wine. 7-8 billion with a “b” bottles of wine per year. Then maybe a little jam. Perhaps what comes across as entitlement is just a prioritization of self-pleasure then - a certain joie de vivre.

Is it inherent in socialism?

Sure, you don’t necessarily associate France with Che Guevara and Karl Marx. But it’s not exactly a hotbed of capitalism and startup innovation. As of earlier this month, polls give French President Emmanuel Macron a 26-31% approval. (For reference, Donald Trump has been around 40% for the last year or so. Even newly non-elected Boris Johnson is at 31%.) Apart from the occasional anti-Macron/pro-Yellow Vest graffiti, rural France seems to be mostly apolitical. Paris, on the other hand, seems to riot at least once a month.

France, like the US and every other developed country in the world, has a looming pension crisis. It’s simple math. Or rather, it’s the combination of demographic decline, aging populations, longer retirements, and chronic underinvestment in pension funds. The assumptions and math can actually get a little complex, but the simple version is “there’s not enough money in pension funds to meet future obligations”. We wrote about this last year in Silver Tsunami. In the US, a while back we raised the retirement age from 65 to 67. We’ve also moved more to direct contribution retirement plans rather than pension plans. We have a lot more to do yet - and it’s a travesty that entitlement reform is nowhere in the current election conversations - so expect the retirement age to get pushed back, again, along with other less-straightforward changes. But back to France. At the moment, Macron is trying to make similar adjustments, but against a backdrop of much stronger union opposition. The current proposal, met with shock and outrage, is to raise the retirement age in France from 62 to *gasp* 64. Mon Dieu!

It was raised from 60 to 62 over 10 years ago...but apparently most public sector employees still retire earlier. So we’ll probably see a bunch of strikes come September as the unions try to shut the country down in order to force the government to back down. Why wait until September? Because the entire country is apparently on vacation during July and August.

France also has 42 different public retirement schemes (one for each profession, pretty much), and Macron wants to unify them all into one single plan. The National Bar Council has chimed in saying that the reforms effectively kill the legal profession in France…because apparently losing the lawyers-only pension plan is the same as losing the “financial independence” of their profession, which “means condemning a profession to economic death and the death of public access to the law”. No joke.

If you want to be a farmer in the US, you plant some crops and call yourself a farmer. Yeah, if you want to be a successful farmer you probably want some experience and knowledge, but pretty much anybody can start farming if they feel like it.

In France, it’s more like a video game where you have to level-up to Farmer. There are certain criteria about income and working time given over to farm activities. You haveto buy in to the Farmers Health Insurance at the Mutual Agricultural Association - the Farmer’s Association that is combination insurance/subsidies/pensions/tax authority on farmers (one of those 42 separate retirement plans mentioned earlier). You may need Professional Agricultural Qualifications, since you have to apply for authorization to farm.

So maybe that’s part of it - maybe socialism carries with it so much System and Bureaucracy around everything that people get a little bit anarchic when left to their own devices?

Is it the taxes?

Or maybe it’s the opposite. Less Lord of the Flies and more...Matrix. Look at taxes. Under current monetary philosophy, if you want to provide a lot of social services as a government, you need a lot of money, which you raise through taxes.There used to be an Elizabeth Warren-style confiscatory wealth tax (thankfully removed by Macron two years ago, despite the riots). There’s an inheritance tax - even if you’re just leaving everything to your spouse! If you leave money to your siblings when you die, the State takes 35-45%. An inheritance of any amount to a niece or nephew results in a 55% tax. Make that 60% to the State if you’re not related to whoever you’re leaving your money to.

And income you ask? Anything more than a part-time job will be taxed at 30-45%. You make $30k a year? Great, you’re in the 30% tax bracket and pay $9k of your $30k to the State in taxes. Make $80k? Say goodbye to $33k of it. (That’s a 41% tax bracket for those keeping track. At only $80k in income.)

There’s a VAT instead of a sales tax, but you’re paying 10% for most food and drink and 20% for pretty much everything else, which means things are just expensive.

Gas is $7/gallon - of which about 64% is taxes (for comparison, the US taxes you 18 cents/gallon and the various states add on another 15-57 cents/gallon depending on the state for an average fuel tax burden of 20-25%).

Roaster chickens are $10, a 4’ x 8’ sheet of MDF is $50, and you can’t even find a 2x4. Lunch is pretty much the same price no matter where you go, even the smallest of small-town villages, which means that your local populations can’t afford to go out to eat. In fact, it seems like most of the South of France economy is entirely supported by UK expats buying summer homes (which does pose a bit of a problem in the future if Brexit actually happens. But we’ll get to that if and when).

Maybe it’s that there’s such resignation to the government taking so much of your day-to-day life that you purposefully try and subvert the system whenever possible. In which case it does kind of make sense that any government proposal is met by riots.

So while on the whole France gives off a massive “not my problem” vibe - not my problem you can’t speak the language; not my problem we close at 2:30 for whatever the French word for “siesta” is; not my problem the train is actually a bus today; not my problem my three-year-old kid takes half an hour to walk up these castle steps in front of you; not my problem you like beer, France makes wine - there are some absolutely wonderful, helpful people; some stunning rolling hill landscapes filled with sunflowers and lavender and vineyards beneath a medieval castle town; and perhaps not “some”, but at least one decent IPA. The wine is cheap and mostly good. The cheese is cheap and mostly great. The sausage is not cheap but is almost uniformly great (and one of the few things that is well-seasoned...for having some of the best salt in the world, they really should use it more in their cooking).

So what’s the moral of the story here - is it eat well, drink well, and just trust (resign yourself?) to the State for everything else? Eh, ceci n’est pas ma problem.

]]>Wed, 10 Jul 2019 04:00:00 GMThttp://www.atiwealthpartners.com/blog/great-expectationsIf last month was Roger Moore as 007, then we’re closing out this summer series with Michael Bay. That’s right - it’s time for stock valuation, replete with explosions, special effects, and very confusing cuts in the action sequences.

Stocks, also referred to as “equity”, are shares of ownership in a company. These used to be issued as actual stock certificates (really decorative pieces of paper), but now it’s just digital 1’s and 0’s. Kind of like the cash in your bank account. When you buy a stock, you expect to make money in two ways. One is by collecting a dividend (which right now averages just under 2% for the S&P 500). The other is by the stock price going up.

Unlike bonds, there is no intrinsic starting point for stock valuation. There is neither a maturity date nor a future value, which makes them more or less impossible to actually value. Not kidding - there are textbooks upon textbooks upon college courses upon certifications all trying to impart some standardization to stock valuation. But that uncertainty is also where the fireworks come in, and why stocks swing they way they do.

Step 1 - Objectively: You can force a time value of money framework on to stocks with some kind of cash flow model. Most stocks pay a dividend, so theoretically the value of the stock should be the sum of all future dividend payments out to infinity discounted back to present value at the required rate of return minus the growth rate of the dividend. Unfortunately, this requires an assumption that stretches literally OUT TO INFINITY and is zero help if the company doesn’t pay a dividend or has negative cash flow (Amazon, Netflix, Tesla, Uber, etc.)Step 2 - Subjectively: The other thing you can do is look at ratios of the stock price to some fundamental metric. Earnings are the most common metric (giving the ubiquitous P/E ratios), but you can use pretty much anything. No assumptions needed for this one, but the ratio in and of itself is meaningless; you need to put it into context. How does it compare to other companies in the industry? How does it compare to itself over the last few years?Step 3 - Clark Gable: Or perhaps in this case it should be “Step 3 - Michael Bay.” What steps 1 and 2 tell us is that stock prices are based on expectations of future earnings. It’s changes in those expectations that cause the fireworks you see in the stock market.Say the Beachcomber is a public company and is expected to have earnings of $1 per share next year, and let’s say it trades at 27 times earnings (roughly what the market is trading at today). That means the price of one Beachcomber share right now is $27. Say because of the trade war, the cost of ink is going up this summer, meaning earnings next year will instead be $0.80 per share. The stock is now worth $21.6 and lost 20% in the blink of an eye. And if the broader economy falls into recession, maybe investors are only willing to pay 20 times earnings instead of 27. So now your stock is only $16, sorry about that 41% you lost.Stock valuation is not about “what is the correct price for this stock”. Instead, stock valuation tries to answer some form of the question “am I getting a good deal”. And at the moment, the answer is about 4-5% annually over the long-term. Whether or not that’s a good deal I will leave up to you.

]]>Sun, 30 Jun 2019 18:00:11 GMThttp://www.atiwealthpartners.com/blog/thats-weirdIt snowed two feet in Colorado on the first day of summer. That’s weird. Blame it on global warming. No seriously - CNN says the reason you had a snowstorm is because the atmosphere is “warmer and moister than before”, and then goes on to mention the 100-degree heat wave hitting Florida. First, slow down CNN. Second, a global warming could theoretically lead to colder temperatures. The sun’s rays hit the Earth directly between the Tropics of Capricorn and Cancer. That’s why they’re hot. The sun’s rays hit the poles very obliquely and get mostly reflected by the atmosphere. That’s why they’re cold. Circulation of that heat differential is largely due to ocean and atmospheric circulation patterns. Global warming could slow down those circulation patterns, which would reduce the ability of the planet to transfer heat to the extent it does currently, and would likely make the equator hotter than it is and northern/southern latitudes colder. Like in the Younger Dryas period or more recently the “Little Ice Age” in Renaissance Europe.Anyway, Earth science tangent aside, the point is unintended consequences (especially when dealing with any sufficiently large, complex, and not fully understood system - like cough cough the economy cough), and how those unintended consequences just tend to make things weird.

A couple weeks ago, the market had a fit. It looked like the China trade deal was completely falling apart and another round of tariffs was coming, and then out of the blue there was a tweet about imposing tariffs on Mexico. The next week, the market was up. Why was the market up? Because of an expectation that bad things happening to the economy would make the Fed more likely to start cutting rates again and possibly even prompt another round of quantitative easing. Recall how the December market drop caused the Fed to completely abandon both their rate hike program and their balance sheet reduction program. In fact, futures markets have gone from pricing in zero moves on rates this year to a full four rate cuts in the next 12 months. (Fun fact: a 1% cut in interest rates over 12 months has always been associated with a recession.)Most all of the economic data coming in recently has been pointing to a slowdown. We’re not in contraction yet, but pretty much everything is slowing down. And yet stocks are up. That’s weird. Actually, everything’s up. The S&P 500 hit a new all-time high as the yield on the 10-year Treasury dipped below 2% (again - and yes, the yield curve is still inverted) and gold broke out to a multi-year high over $1,400/oz. Gold going higher and treasury yields going lower does not signal that all is well with the economy. And for it to happen while stocks continue to go up on…nothing, well, that’s weird, too.

As of Monday July 1st, this will officially be the longest economic expansion in US history. And yet we’re about to dip back into “extraordinary” monetary policy that has only ever been used in the depths of the Great Financial Crisis. That’s weird. Another all-time high from earlier this month: the amount of negative-yielding sovereign debt. It just passed $13 trillion with a “t”. You know what doesn’t happen in a rationally functioning economic system? Negative-yielding debt. Here’s a table snapshot that focuses on Europe. Anything highlighted in red has a negative yield.Before you look though, do a quick thought experiment. How much would you charge in interest to loan someone money for 5 years? What about 10 years? What about 30 years? What if that “person” was the government of Switzerland? What would you charge the government of Switzerland if they needed a loan for 30 years?

Unless you answered with “not only would I not charge the Swiss government anything, I would pay themevery year for 30 years for the privilege of loaning them money,” then you are wrong. Or perhaps it is not you but rather something about the world that is wrong.

But there’s more than one problem with a market that’s up 18% as everything else is up as well. Let’s assume for the moment that the stock market is correct and the bond market is wrong - what we mean by this is that stocks are correctly pricing in strong economic growth and bonds are incorrectly pricing in a coming recession, resulting in a large drop in bond prices to resolve this weird Schrodinger’s Cat of a market. (Fun fact: this is almost never the case - history has shown that the bond market is much more reliable than the stock market, so in cases of divergence like this it’s usually stocks that end up “catching down” to where bonds are.) But we’ll assume that stocks are correct and economic growth is solid and will continue. Here’s the problem. Long-run economic growth has a cap on it. When looking at the economy as a whole, economic growth comes from two places and only two places: population (labor force) growth and productivity growth. Labor force growth has been averaging around 0.5% for the last decade. So has productivity growth. That means that structurally, long-run economic growth is capped closer to 1% at the moment. Let’s be generous and assume healthy increases in both labor force and productivity going forward as the labor force become increasingly made of up robots that can work around the clock. We’ll also be generous and assume that all real people are still working as well and not just sitting at home getting their government-provided “living wage”. Let’s assume both of those together get us back to the post-WWII boom period where labor force growth was closer to 2% and productivity growth was closer to 2.5%. That means that long-run economic growth could get back up to over 4%.The stock market as a whole is bound by the long-run economic growth of the economy. There’s a lot of cyclical noise in stock markets that overrides that signal, but long-tem durable gains are limited by the cap on underlying economic growth (and inflation). Here’s a chart from John Hussman illustrating the point using market data all the way back to the Great Depression:

It’s a really busy chart, but pay attention to the dark red horizontal lines. These represent the durable market gains. Note how not uncommon it is throughout history to periodically revisit market levels last seen several years earlier. He’s using the green line as a measure of “normal” valuation to make a point that much of the market gain since 2009 is likely transitory and not durable; we’re not going to go that far. We will say, however, that sustained market gains above and beyond long-run caps effectively “pull forward” future returns. So 18% market returns in a year is not wrong, per se. But it does mean that all else equal, you are currently pricing in an assumed growth rate for several years into the future such that if the rate actually materializes as assumed, there should be zero market growth to get back to the same valuation levels you had at the start of the 18% year.Of course, this itself assumes that people actually trade stocks based on assumptions of growth rates and fundamentals. Which would normally be the case except for another of those unintended consequences of the Fed’s monetary policy: namely, stock buybacks. The single largest source of demand in the stock market in the last decade has been corporate buybacks. According to Goldman Sachs research, net corporate buybacks in the US market since 2010 have averaged $420 billion per year (and crossed $1 trillion with a “t” in 2018). Over that same time period, average net demand from households, mutual funds, pension funds, and foreign investors combined was less than $40 billion per year.Corporate stock buybacks are bad enough in and of themselves as a tool for market manipulation and insider trading, but corporations have been literally taking on new debt just to buy back their own stock. All thanks to the Fed’s zero-interest rate policies of the last decade. If you actually want to do something realistic about economic growth and wealth inequality, start with banning corporate buybacks. And then reverse that terrible Citizens United decision. Alright, soapbox over. We’ll save the political economic analysis for next year when there’s actual policy proposals to discuss and it’s (hopefully) less of a circus. The point of this newsletter was that markets ended the second quarter above their 200-day moving average. For our investment management clients, that means we should be fully invested in equities. But we’re not. There’s just too much weirdness going on at the moment for us to feel comfortable taking on that kind of risk, especially when it all seems to be predicated on an assumption of aggressive Fed easing coming soon - easing that, by all indications, would be due to the onset of a recession. We’ll leave you with a couple market snapshots to digest. Each one of these covers a 2-year period. Here’s the S&P 500 making new all-time highs:

Here’s the broader US market over the same time period (the NYSE Composite Index) not making new highs (not only not making new highs but still down ~9% or so from January 2018 levels):

Here’s global stock markets (represented by MSCI ACWI) over the same time period most definitely also not making new highs:

And here’s all three of them on one chart. S&P 500 in blue, NYSE Composite in purple, ACWI in orange:

Is that the S&P 500 up 9% more than the broader US market? Yes, yes it is. Weird.

Young adults face financial complexities such as student loans, new mortgages, or car debt, coupled with low-paying entry-level jobs. With so much on their plate, those in their early twenties might feel overwhelmed by the words “saving,” “retirement,” or “investing.” If you’re in this situation, is it too early for you to start investing?

Paying off debt vs. investing​If you’re paying off debt, it may seem counterintuitive not to put every cent towards that goal. The key is to make sure that the amount you earn in interest in your investments is larger than the amount you are paying on your debt. Michael Kern, founder of Talent Financial, says, “The return you get from investing in the stock market varies greatly, but most people say you can conservatively expect around 5 to 7 percent return. So, if your debt carries about the same interest rate as the average return on the market, then it makes a lot of sense to pay it off rather than invest.”

For example, let’s say you have a mortgage at 4 percent. With an average 401(k) you can earn an interest rate between 5 and 7 percent and take advantage of employer matching. In this situation, it might make sense for you to opt for a lower monthly mortgage payment and put your extra dollars towards investing.

Steven Nuckols, founder of Wealth Compass Financial, says, “If you had the money to pay cash for a house, you would save on the 4 percent interest, but you would have an opportunity cost of 10 percent on average by passing up on investing in the stock market. You would also be passing up the tax write off of a mortgage interest deduction.”

However, other factors to think about before this decision might include taxes associated with investments, the reliability of your income, and the emotional security that comes from living debt free.

Some debt, like credit card debt or personal loans, carries high interest rates. Financial advisors like Rick Vazza of Driven Wealth Management agree that debtors should strive to pay off their credit cards as soon as possible. Vazza says, “Without question, we always encourage paying off credit card balances prior to investing. Most of the rates are into the 20 percent [range] and an investor will benefit from paying these balances off prior to investing.”

Finding balance

Logic proves that you can’t live a normal life now if you put all your money to saving for the future. Everyone has monthly bills. In contrast, it’s unwise not to save any money for the future. Gage Kemsley, vice president of Oxford Wealth Advisors, says that young adults must learn to “balance between paying off debt and saving for the future. I usually see the scale tipped too far one direction — someone throwing their entire paycheck to the debts they owe, like a mortgage, car or student loan with nothing going into their 401(k), Roth IRA, or savings account.”

Matt Ruttenberg, a financial expert and co-founder of The Money Twins, recommends keeping in mind your short-term savings goals so that you won’t need to take out your long-term savings or investments. “Many young families know there are a lot of things to check off the ‘grown-up financial checklist’ and investing for retirement is usually what comes to mind first. But most of the time, that is their longest-term goal. And, when it comes time to check off their short-term goals, like purchasing a home, they tend to pull money from their long-term bucket. This can be a very costly mistake with taxes and penalties from the IRS when cashing in your retirement accounts too early.”

Russell Robertson, owner of ATI Wealth Partners, adds, “I tell clients that investing should only be undertaken with long-term money; that is, money that they don't plan on touching for at least two years. I tell people to have 6 to 12 months of expenses in cash as an emergency fund, then additionally keep any money you know you will need in the next one to two years in cash as well.”

A great option to grow your short-term savings is to put your money in a high-interest savings account such as those provided by many online banks. See our rankings of the best online banks here.

In regards to preparing to invest by creating an emergency fund and making sure you have enough money for upcoming purchases and bills, Jonathan DeYoe, author of Mindful Money, says, “Saving is not the same as investing. Saving is a prerequisite to investing.”

Starting to invest

If you want to invest, make a monthly budget of your expenses and income. This will show you how much you have left to put towards investments and where you can cut back on spending. With a budget in place, you can make a plan for your investments. Azhar Hirani of ZT Corporate advises, “For young adults who are interested in investing, the number one piece of advice is to get a plan down. It is important to have a clear picture of what you are trying to achieve in the long and short-term. Short-term investments mean that you’ll expect a return within five years. Examples of short-term investments include high-yield savings accounts, CDs, money market accounts, treasury bills, and government bonds. Long-term investments are equity type investments, such as private equity funds, stocks, real estate, etc. — returns that increase over time.”

Automatic investments make investing simple. Jeff Badu of Badu Tax Services says, “Set a monthly budget and put an investment amount (say $5 a day) in the budget. You can start small and increase your investments as your income increases. Try to use an automated investment app, which will make this similar to how people contribute to their 401(k)s. Once you establish a habit of investing, you’ll be an investor for the rest of your life.”

As you begin your investment journey you must remember that it’s just that, a journey. Patricia Russell, founder of FinanceMarvel, says, “It is important to remember that investing is the proverbial marathon as opposed to trying to find a stock that will double overnight.” Robert Johnson, a finance professor at Creighton University, says, “Trying to pick winners, for most, is a loser's game. The solution is to invest in diversified funds and you don’t need to pick those winners.”

David Bakke, an investment expert at Money Crashers, says to watch out for fees when you’re investing, “One key thing to look for is a low expense ratio (which is basically the fees needed to manage the account). What you want is one that is 0.50 percent or less.”Other kinds of investmentsRemember that not all investments include putting your money away to earn interest. As an up-and-coming professional you can invest in higher education, certifications and licenses, business ventures, and opportunities to increase your earning power.

Bobby Casey of Global Wealth Protection agrees that not all investments look like stocks: “You need to focus on building a business or capital assets that can create passive income for your future. There are many avenues to achieve this; build a business that you later sell for $X millions, build a real estate portfolio, or build a cash flow business that is not directly tied to your time input.”

A financially stable foundation now will positively influence the rest of your life. Is it too early to start investing? The experts say no. You have investment options for any stage of financial growth.

​​

]]>Mon, 10 Jun 2019 04:00:00 GMThttp://www.atiwealthpartners.com/blog/bonds-james-bondsBonds, unfortunately, are nowhere near as exciting as the actual 007. Or at least, they’re not supposed to be. Maybe a Roger Moore 007 though, those were all pretty boring. A bond is an IOU - a promise to give your money back in the future with periodic fixed interest payments in the meantime. They used to be issued as actual certificates, with little coupons that you would clip off every six months and turn in to receive your interest payment, but alas, those days are gone. So, if you get your money back (let’s call that amount “100”) at some point in the future and in the meantime are collecting interest payments, how much is that bond worth? 100? 102? 96?

It’s the same basic question as the time value of money from last month. Bond valuation is based on two things: 1) the interest rate of the bond relative to the current interest rate in the market, and 2) the quality of the company issuing the bond. So going back to last month’s three-step valuation methodology:Step 1 - Objectively: Earlier this year, 10-year US Treasury bonds had an interest rate of 2.5%. That rate is fixed for the life of the bond (hence “fixed income”). Right now, the interest rate is about 2.1%. That makes the bond issued at the start of the year more valuable, because it’s paying 2.5% instead of 2.1%, so it will be priced higher than 100 (more like 103 or 104). If interest rates had instead gone up, then the value of the 2.5% bond would have gone down.Step 2 - Subjectively: In last month’s example, the future payout was guaranteed. In the bond world, repayment is not guaranteed because the company might default (go bankrupt), so you much adjust valuations based on potential default risk. If you have a 10-year US Government bond yielding 2.25% that is priced at 100, you would probably have a 10-year General Motors bond yielding 2.25% that is priced around 85, since GM has a greater risk of bankruptcy than the US Government. (In actuality, it’s more likely that you would see the GM bond priced closer to 100 but yielding more like 5% in that case, because nobody in their right mind would buy a GM bond that only yielded 2.25%...)Step 3 - Clark Gable:...or would they? Because interest rates have been kept at or near zero for the last decade, the bond market is now much more Pierce Brosnan 007 than Roger Moore. (filled with action and absurdity). For example, Argentina issued $2.75 billion of 100-year bonds at 7.125%. Please note that Argentina has defaulted on its debt roughly once every 25 years for the last two centuries. Also, you will not be alive when that debt matures, so you effectively never get your money back, default or no default. Further, there is currently $10 trillion (with a “t”) in debt globally that has a negative interest rate. That’s right, you don’t get any interest payments; instead, you actually have to pay interest yourself to own the bond. Absurdity.Some piles are good. Piles of sand, for example, create dunes that help protect the island from the next storm. Piles of debt do the opposite and make the economy more vulnerable to the next storm. And apart from that pile of negative yielding debt, we’re also sitting on the biggest pile of corporate debt history. If all that sounds a bit frothy, well, what can we say. We like our bubbles shaken, not stirred.

]]>Fri, 31 May 2019 04:00:00 GMThttp://www.atiwealthpartners.com/blog/the-return-of-voldemortDark Marks have been flying around recently like it’s the Quidditch World Cup. Here’s a brief selection:

Inverted yield curve (the 10-yr yield has been below the 3-mo yield for 6 days and counting. Emphasis on “and counting” after that ridiculous Mexican tariff tweet last night).

Most reasonable levels of market support have been broken (again, thanks to last night’s tweetstorm).

Global exports lowest since 2009

Falling auto sales

Crumbling manufacturing activity

Service sector slowdown

Disappointing capital goods orders

US home prices down 12 months in a row

Highest credit card delinquencies in 8 years

And then there’s the dead unicorns.

What’s a unicorn? In investing parlance, it’s a private start-up company with a $1B valutation. At the moment, there are over 300 such companies around the world. Here’s a fun visual breaking down the unicorn universe:

You may have noticed that Lyft, Pinterest, and Zoom aren’t on there. That’s because they already went public by the time that infographic was put together. Since the infographic, Uber has gone public, in what was possibly the worst IPO in all of history. Unicorn blood everywhere.Let’s take a look back at the life cycle (end-of-life cycle?) of a unicorn and see what it means when these things start getting slaughtered in the Forbidden Forest of the stock market.These companies start with basically nothing except an idea, and generally self-fund some prototype or proof of concept or rudimentary app development. They then take their idea and pitch it to early-stage investors called venture capital firms (VC) - exactly like what you see on Shark Tank or Dragon Den: “Here’s our idea, we need $250k to get this up to scale in our market. In exchange, we’ll give you 20% of our company.” Then you have some negotiation around the terms of the deal, but let’s say the company gets $250k for 20%. That gives them a valuation of $1.25M.Fast forward a bit, they use the $250k to successfully scale up and now want to expand into new markets. They have more of a proven track record at this point, so there are more people willing to listen to the company’s pitch in the next funding round. Still mostly VC firms, but maybe some private equity firms as well. Maybe now they need $2M to expand along the East Coast, and let’s say they get the $2M investment in exchange for 15% of the company. Now they’re valued at $13.3M.Fast forward a bit more through continued successful growth, and now maybe they want to expand west and need $20M dollars to immediately get scale in, say, Texas and California. Another successful funding round and say they get the $20M in exchange for only 8% of the company. Now they’re sitting on a $250M valuation.Another successful funding round or two and voila! you have your very own unicorn once you get to a $1B valuation.Crucially, please note that you aren’t a unicorn because you have billions of dollars in sales, or revenue, or profits. You’re a unicorn because somebody thinks that’s what you’re worth...kind of like stock valuations. To use hyperbole to prove the point, let’s say we started making a gizmo. It’s a mildly entertaining cat toy kind of gizmo, and we get a $100k investment for manufacturing purposes in exchange for 40%. That makes us a $250k company. Then, let’s say there’s a rich old recluse down the street who is mildly off his rocker and also happens to be a crazy cat person. He sees our toy, knows us, knows that we used to cat-sit for him back in the day, and decides to give us $10M for a token 1% in the company so we can entertain all the cats in the world. $10M for 1% gives us a $1B valuation. Boom, unicorn.It’s unlikely that many of the current unicorns got that way because of crazy cat people. But might a decade of 0% interest rates and an additional $3.5 trillion dollars pumped into the economy have had something to do with it? Absolutely - that’s basic supply and demand.But back to the unicorn life cycle. Now you’re a well-established, fully-horned unicorn, and you live happily ever after. The End.Or not. There are several private multi-billion dollar companies out there that will likely continue operating privately happily ever after. Cargill, Koch Industries, Chick-fil-A...these companies all retained control by making money “the old fashioned way”, through growth and acquisition. The reason they’ll stay private is that taking your company public is actually a massive hassle. It’s expensive, you lose a lot of control, and there’s a lot more regulation you have to deal with. In short, probably nobody would do it if they didn’t have to.But unicorns have to. They didn’t make money through growth and acquisition, they made money because a bunch of different investors gave them money. Threw money at them, really. And eventually, those VC and private equity funds will want to see their money back. That initial $250k investment for 20%? It’s now worth at least $200M. Where are you going to get $200M to repay that investment? You don’t have it just lying around, you’re a finely-oiled business machine! You’re probably not going to take on $200M in debt to cash them out. You’re probably not going to get another private equity firm to buy them out because a) that’s a large chunk of money and b) by this point your future unicorn returns won’t be as attractive as the next pre-unicorn out there (would you rather invest $200M in one company that might grow to $300M in 5 years, or $250k each in 800 different companies, any one - or all! - of which might turn that $250k into $200M in 5 years? Exactly.) That leaves pretty much one option - the public stock market, via IPO (initial public offering).There are two reasons why VC and private equity firms want their money back. One, to pay off their investors. Two, because they think there is better opportunity elsewhere...which means your company has either reached a growth plateau or a public demand plateau. Let’s be crystal clear about this: companies IPO in order to lock-in returns for their early-stage investors. And nothing screams “caution” like a bunch of these really sophisticated early-stage investors deciding they need to get their money out all at the same time.So now comes the IPO. IPOs are all about telling stories. You want to drive up demand in the public market so that people will want to buy your stock when it opens. The more people that want to buy it, the more the price will go up. The company releases a prospectus, some slick marketing materials, and then literally does something called a “roadshow” to try and generate demand in the market ahead of the IPO. The price of the IPO is a delicate balance between maximizing cash for the company and making a good public impression. Sure, maybe you could get $45 per share and just have the stock trade there all day; but would it be better if the stock opened at $35 and immediately jumped up to $45 to show a 30% gain on day 1? It’s all about the marketing.

A successful IPO is one in which the shares start trading and go up. If an IPO is priced too high or there’s not a lot of demand, the shares will drop. The companies managing the IPO will generally “support” the IPO by buying shares at the IPO price so that the stock doesn’t show a loss on the first trading day, but that’s bad optics.

Here are some notable recent IPOs:

Lyft - Initial suggested IPO range was $62-$68. Actually IPO’d at $72. Lots of shadiness around the IPO, with accusations of short-selling against the IPO by the same firm that was managing it. Lyft initially opened about 20% higher, then faded. Mediocre-to-disappointing/confusing IPO. (Lyft shares fell below the IPO price on day 2 of trading and still haven’t recovered).

Pinterest - Initial suggested range was $15-$17. Actually IPO’d at $19 and jumped up to $24 on day 1. It peaked at $30 and has since tailed off back down to $25. Pretty successful IPO.

Zoom - Initial suggested range was $33-$35. Actually IPO’d at $36 and closed day one at $62. Since then, it has gone up to $79. Great IPO.

No other company has been as large, well-known, anticipated, and yet IPO’d as poorly as Uber. Facebook was the biggest flop of the last decade, but it at least opened up 25% or so before needing a lot of support to hold the IPO price by the end of the day. Note that those other three companies IPO’d above the anticipated range. Uber IPO’d at the bottom end of the range. Not a great start, that. But to make matters infinitely worse, the opening price was almost 7%below the IPO price! That’s...almost unheard of. Uber used to be valued at upwards of $120B. After that IPO, it’s worth less than $70B. Fun fact: that means that over 80% of the money invested in Uber is underwater now.

Realistically, Uber (and Lyft) should probably be worth...absolutely nothing at the moment. Companies have to give potential investors a look at their financials before the IPO. Add Uber and Lyft to the list of companies that don’t make money. In 2017, Lyft had $1.1B in revenue but a net loss of about $700M. In 2018, they had $2.2B in revenue but a net loss of over $900M. Lyft just reported their first quarterly earnings as a public company and expects in 2019 to generate $3.3B revenue but a net loss of over $1.1B. Uber, before the IPO, told investors that it may never actually make a profit. In 2018 Uber had $11B in revenue...but a net operating loss of over $3B. And for the first quarter of this year, they lost over $1B on $3B of revenue.

Question: How much would you pay to own a company that loses literally billions of dollars a year? Answer: Objectively, nothing. Subjectively, anything that is slightly less than someone else is willing to pay in the future.

And that’s the problem here. The entire point of the IPO process these days is to stir up a bunch of those “willing to pay more in the future” people with a lot of hype and smoke and mirrors. All of these large, well-known IPOs are not a positive economic signal, it’s a sign that future growth prospects are diminishing and your VC/private equity firms are trying to cash out at the top. When there’s not even enough demand to open at a low IPO price for a well-known and fairly popular company, that’s a pretty good indication that the top for valuations may be in the rearview mirror.

Unicorns have been the darlings of the investment world for the last decade. It’s not a good sign when they start dying in front of you.

​It may or may not also mean that He-Who-Shall-Not-Be-Named is about to return, so brush up on your expelliarmus this summer. Or, better yet, learn some real fighting magic because the premise that expelliarmus is good enough to stand up to the Unforgivable Curses is absurd.

]]>Tue, 07 May 2019 04:00:00 GMThttp://www.atiwealthpartners.com/blog/time-value-of-moneyLast month we started big - economic theory big. Now we’re going to look at stocks and bonds. More specifically, what are they and how do you know what they’re worth?

If you’ve never spent a Sunday watching Antiques Roadshow on PBS, your life is missing something. Especially the British version. The gist of the show is that a bunch of appraisers travel around, set up shop, and then people bring all of the stuff that has been lying around their attics for the last 25 years to see if it’s worth anything. Stocks and bonds work pretty much the exact same way, just with more of an auction house component...but before we get into that, we need to discuss something called the time value of money.

Time value of money is the idea that a sum of money is worth more today than the exact same amount in the future, due to the potential earnings of the money if you had it today. Say we were going to give you $100,000 in 10 years, guaranteed. How much would you take right this second to give up the $100,000 in 10 years? Would you take $30,000 right now, today, instead of $100,000 in 10 years? What about $50,000? $80,000? How do you even start answering that question? (As an aside, this is exactly the business model of companies like JG Wentworth - you know, the one with commercials of operatic bus riders telling you to call 8-7-7-Cash-NOW!)

​Step one: objectively. You can find an FDIC-insured online savings account that pays 2.0% interest right now. If your money is just going to sit there at 2.0% then you would need to start with about $82,000 to get to $100,000 after 10 years. If you were going to invest the money in the market and thought you could get 5% returns for 10 years, then you would only need about $61,000 to have the full $100,000 after 10 years. The present day value of that future $100,000 is going to depend on what kind of returns you assume your money can get in the interim.Step two: subjectively. This is where the art comes in to the valuation process. Maybe you could get 5% returns in the market, but you personally don’t like that kind of risk. Maybe you personally would just stick the money in a 10-year CD at the bank yielding 2.5%. If that’s the case, then you shouldn’t be willing to accept $61,000 today in exchange for $100,000 a decade from now, even though Russell Robertson, Beachcomber contributor and investor extraordinaire, might think that’s a perfectly fair offer.Step three: Clark Gable. Because frankly, my dears, sometimes life gets in the way of the purity of the numbers and just doesn’t give a damn. Same scenario as above, and you’re going to put the money into a 10-year CD at 2.5%. Or were, until you out of nowhere got appendicitis and have a $20,000 hospital bill to pay. Might you accept $61,000 today even though that’s technically, given your personal preferences, less than the present value of $100,000 a decade from now in that scenario? Might you even accept $50,000? Yes, we daresay you might. (And that’s how JG Wentworth makes money, if you were curious).Alright, intro to securities valuation over, class dismissed. Come back next month as we move into the real world of bonds, stocks, and central bank-induced stupidity.

]]>Wed, 24 Apr 2019 04:00:00 GMThttp://www.atiwealthpartners.com/blog/very-superstitiousDo you ever find yourself pulled back through history and imagining what life was like for a particular group back in the day? Like the Mayans, or the Romans, or the French aristocracy? Or maybe you looked at the Super Blood Wolf Moon eclipse this January and wondered how many past regimes had been overthrown and leaders axed (literally) because such things were perceived as having lost the favor of the gods? Or maybe not and we’re just weird like that.

In any case, this is an April newsletter, so dust off that aluminum foil and let’s pull back the curtain on the collective solipsism behind the not-so-invisible hand that guides our markets. Also, put 1984 back on top of your summer reading list. Ready? Let’s go.

A superstition is a belief that a seemingly innocuous action holds some sort of meaning or control over much larger, uncontrollable cosmic forces. Mirror breaking, walking under ladders, crossing paths with black cats, stepping on cracks - these are all pretty common examples. Athletes have their own superstitions, though they tend to be looked on more favorably and referred to as “routines” or “rituals”: wearing red on Sunday (Tiger Woods), eating two chocolate chip cookies before games (Brian Urlacher), not changing clothes (many people). On the other side of the spectrum, you’ve got the more maligned tea leaf interpreting, palm reading, tarot, and crystal ball gazing. And from the annals of history, apparently spitting on yourself stopped you from “catching” epilepsy, the ashes of a redhead on your field guaranteed a good harvest, and you’d be victorious in battle if your chicken ate cake.

In essence, superstitions are a kind of magical thinking that may occur on an individual level or on a much broader societal level. In fact, pretty much every early society had some form of this magical thinking as a foundational part of their culture as a means to both explain and control the larger forces of nature around them. Allow us a little leeway in letting such a broad assertion include: the presence of magicians in biblical Egyptian courts, the offering of sacrifices to various gods for particular purposes across pretty much all cultures (you wouldn’t find Achilles in the Temple of Dionysius before battle, for example...unless Brad Pitt’s portrayal was historically accurate), Native American rain dances, the witches of Shakespeare’s medieval Scotland, the Oracle of Delphi, and shamans/sages/seers in general.

In the abstract, a select group within society is responsible for performing/saying/doing the right ritual/spell/invocation to get the desired result. Such a spell is written in a language that you can’t understand if you’re not part of the select priestly group, which gives them an automatic sense of authority. More importantly, however, the rest of society believes in the power of the acts performed by the priestly group to actually deliver that result.

Superstition tends to be associated with knowledge and education, or rather the lack thereof. We now know about and can even model weather patterns, eclipses, soil nutrient levels, diseases, etc. without needing to rely on dancing, human sacrifice, or dearly departed gingers (sacrificed or other). This tends to make one look back on these previous societies as somewhat “primitive” - the idea that this group magical thinking is a consequence of lack of knowledge and that we, as a result of the inexorable progress of humanity through time, have transcended the need for such lowly superstitious beliefs.

Ha. Hahaha. Hahahahaha. More on that later.

This magical societal groupthink has been so prevalent throughout history that there is a well-documented sequence of events in such societies as they begin to decline. And it goes like this:

Usually, there has been some external forcing that makes the spell no longer effective. By “external forcing”, we mean shifting weather patterns, climate change, natural disaster, elephant invasion across the Alps...something outside your control that reveals the simple fact that your spell does not, in fact, work to control those things like you thought it did. When the spell doesn’t work, the immediate response is to do it again, but more and better. More chanting, perhaps, or more vigorous dancing, or purer ingredients. If that still doesn’t work, then you have to change it a little bit. Left foot instead of right foot. Counterclockwise instead of clockwise. Female redheads instead of just any old ginger. When that still doesn’t work, the rest of society quickly loses their belief in the power of your spells, and you’re in trouble. You are replaced by a populist-led new regime that brings new spells for the people to believe in, and the cycle starts all over again.

And there you go. You can find endless examples of this cycle throughout history. In fact, if you have a lot of time on your hands and enjoy non-fiction, add The Golden Bough to your summer reading list as well.

But back to the point about knowledge and education replacing magical thinking and superstition in our modern society. Where were we? Oh yes:

AhahahahahAHAHAHAAHAHAHAhaha. Ha. ​Consider our present-day society in the context of the above framework, if you will. We’ll leave to the side all of the obvious political analogies and instead focus our attention squarely on the Federal Reserve.

The Fed uses spells. Here’s one:

We couldn’t find a straight black-and-white version of this, so presumably the colors are part of the spell as well…

What’s that one, you ask? That’s called the Gaussian Copula. That’s the spell that let subprime mortgages get packaged into AAA-rated securities. Oops. Though technically, that one’s not on the Fed but rather on Wall Street in general.

Here’s another one:

What’s that one, we hear you asking again? That’s called the Taylor Rule, and this one is squarely on the Fed. It’s how the Fed uses interest rates to control inflation. Basically, it says that if interest rates are low, you print money and interest rates go up. Oops.

So the Fed uses spells, written in a language that nobody really understands unless you’re part of their chosen group. The hole themselves up in marble buildings located in major cities across the country, meet 8 times a year, and then with appropriate pomp and circumstance share their wisdom from on high with the masses at quarterly press conferences.

Huh.

For decades now, the hard sciences have recognized that natural systems are complex and virtually impossible to model, let alone control. It’s why hurricanes have a probability cone around their path. It’s also why biologists understand that ecosystem-wide impacts are more than a simple cause and effect lever you can pull. The Fed, however, is not nearly as modest. They still labor under the delusion that they can control the inexorable forces of business cycles and human nature. So what happens when their spell doesn’t work? Well, let’s recap the timeline:

2008: Fed spells call for money printing. They called it “Quantitative Easing” (QE) and printed about $600 billion. It didn’t really work, so…

2009: More money printing! The QE program was extended by another $750 billion or so. That still didn’t really work, so…

2010: More, slightly different QE! Or “QE2” as it was called, to the tune of about another $1.2 trillion with a “t”. That still didn’t really work, so…

2011: More, slightly different different QE, called “Operation Twist”. That still didn’t really work, so…

2012-2014: Back to the original QE plan, just on an ongoing monthly basis, for another $900 billion or so.

...when the spell doesn’t work, the immediate response is to do it again, but more and better. More chanting, perhaps, or more vigorous dancing, or purer ingredients...If that still doesn’t work, then you have to change it a little bit…​Maybe the inflation target will become 4% instead of 2% inflation. Or maybe inflation isn’t the right magic word anymore and instead it will be “nominal GDP growth”. There will be tweak after tweak as the Fed tries to pull its little lever and control the inexorable, uncontrollable force of business cycles. At the moment, there’s a lot of talk about something called the “natural rate of interest”. The theory goes that QE didn’t work because there wasn’t enough of it. Yes, rates were at 0% for 10 years, but the “natural rate of interest” was negative and rates need to be below the “natural rate of interest” to be stimulative.

Eureka!That’s it! Financial conditions were just too tight with a decade of 0% interest and $3 trillion of money printing! (Also, “natural rate of interest” is in quotes because while it is a theoretical entity, it is impossible to ever determine or measure in the real word. But it sounds good, right?). They are quite literally making this up as they go along.

...when that still doesn’t work, the rest of society quickly loses their belief in the power of your spells, and you’re in trouble...

How do you try and hold on to credibility? By getting even more abstract (see “natural rate of interest”). By justifying your policies in light of social flashpoints (the European Central Bank released a study earlier this year “finding” that their quantitative easing policies actually lessened inequality). By promising stronger spells in the future (the San Fran Fed released a paper earlier this year “showing” that negative rates would have led to a faster economic recovery).The tax-cut and supply-side Chicagoans (remember your history of economic theory?) have had a good run of it for the last 40 years, but their spells aren’t working anymore, and their regime is starting to crumble. Think it’s just coincidence that this is happening at the same time Modern Monetary Theory is gaining prominence?

...you are replaced by a populist-led new regime that brings new spells for the people to believe in, and the cycle starts all over again…

Have you heard of Modern Monetary Theory (MMT)? It’s all the rage right now and is completely absurd. Why, you may ask? Good question! Let’s take a whirlwind tour through the history of economic theory to find out.

Starting with the industrial revolution, economic theory was dominated by the Austrian School (so named because it originated in, wait for it...Austria). Austrian thinking is all about free markets and the idea that the business cycle is both driven by supply and self-correcting.

But then the Great Depression happened, which gave rise to the Keynesian School (named for John Maynard Keynes), which basically said nein you Austrians, supply-side is the wrong focus; you need active government intervention (“spending”) to pull the demand-side lever and get any recovery when you’re in a depression.

So of course the government started profligate spending any time there was just a slight economic hiccup, which caused massive inflation in the 1970s. Some guys from the University of Chicago showed that government spending doesn’t impact growth and that controlling the money supply was the best way to regulate business cycles. This is called the, wait for it again...Chicago School.

Theoretically, that’s where we are today: Chicago-style monetary policy (run by the Fed), with some bastardized Keynesianism (fiscal policy) thrown in when things get especially bad - remember that “shovel-ready” stimulus package in 2009?

In practice, however, we’re keeping rates artificially low while tightening monetary policy in a low inflation environment and simultaneously running record deficits 10 years into a recovery. That counts as “doing it wrong” no matter which school you subscribe to.

Next up in “doing it wrong” will be MMT. Austrianism, Keynesianism, and the Chicago School all frame policy within the context of supply and demand. The key insight of MMT is that the laws of supply and demand are irrelevant at a national level; budgets and debts don’t matter. You can never go bankrupt because you can just print more money.

Government spends as much as it wants on whatever (universal income, Medicare for all, a massive border wall - there’s something here for everyone!) and then prints enough to cover said spending. Naturally, unlimited money printing causes inflation, so the way you remove money from the system and keep inflation in check under MMT is: taxation. That’s right - if inflation gets out of hand in the MMT economy, politicians must raise taxes. Good luck with that.

In all seriousness, there is a sound-ish theoretical basis here. Money has no intrinsic value, so under MMT, you would probably link money to labor; a dollar is worth 4 minutes of labor, say. That’s a $15/hr minimum wage, with a government-guaranteed job plus healthcare and education for everyone. You’d also need price controls - a gallon of milk is ten minutes of labor, a pound of meat costs half an hour of labor, etc. Conceptually, one could imagine a labor-based society dominated by central planning in which MMT is a perfectly descriptive framework.

As Ms. Ocasio-Cortez has said, it’s a question of what kind of society we want to live in. Just keep in mind as you hear about this magical utopia that there has been maybe one successful case study of central planning in history. Maybe. And regardless of any sound theoretical basis, the transition from our current economic system to an MMT-descriptive system would hurt more than any sunburn you’re going to get this summer.

]]>Mon, 18 Mar 2019 04:00:00 GMThttp://www.atiwealthpartners.com/blog/flips-and-flops-or-reliving-super-bowl-49Happy Spring! The clocks have all been changed, the equinox is behind us, and summer fast approaches. The Fed apparently decided to get a head start on flip-flop season, however, by going full Left Shark this week.

As a reminder, this is what the Fed said just three short months ago, back in December (italicized parentheses our own):

“...the labor market has continued to strengthen and...economic activity has been rising at a strong rate. Job gains have been strong...household spending has continued to grow strongly...overall inflation...remain[s] near 2 percent...In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate (i.e., another rate hike)...”

This, of course, was the rate hike that “broke” the market, causing a steep and sudden 20% drop in stock prices. In response, it was widely reported that President Trump discussed firing Fed Chair Powell. Fortunately for markets everywhere, Powell kept the independence of the Fed - nope, scratch that - his job, and a combination of appeasing press conferences about future rate hikes and China trade deal progress along with market technicals led to a similarly fast and furious market rally into January and beyond.

So, here’s the big-picture setup for the Fed’s performance this week:

A million years ago, back in December 2008, the Fed embarked on a decade of extraordinary (read: never been done before) monetary policy in response to the Great Financial Crisis. This extraordinary monetary policy involved two things: 1) dropping the fed funds rate to 0%, and 2) buying up treasury bonds and mortgage-backed securities as a means of injecting money into the financial system.

Starting (finally!) in 2015, the Fed began to “normalize” it’s policies, given that the bottom of the Great Financial Crisis was old enough for 2nd grade at that point. There was one rate hike in 2015, one in 2016, three in 2017 and four in 2018. Also in late 2017, the Fed started reducing its balance sheet. All those $3.5 trillion (with a “t”) treasuries and mortgage securities it had been buying? Well, it stopped actively buying in 2014 and had just been reinvesting any maturing issues, but in 2017 it started letting the issues mature without reinvesting the money, thereby effectively taking money out of the financial system and reducing the size of their balance sheet back to - wait for it - normal.

The December market-breaking hike is presented in official Fed-speak above, but let us translate for you:

"Things continue to look rosy in the second-longest economic expansion ever. Sorry if previous Fed iterations contributed to blowing a massive stock market bubble, but it’s not our job to save you from stupid investment decisions. As such, we will keep on the path of policy normalization by hiking rates and reducing the size of the balance sheet as we have painstakingly said we would do for the last two years now.”

Sure, it’s not quite 14-14 at the half between the Pats and the Seahawks, but you get the idea. With that as the backdrop, here’s what the Fed delivered on Wednesday:

No rate hike. But not just no rate hike! Oh no, they said no rate hikes at all the rest of this year with one more expected next year (yeah, right).

In a Monty Python-esque move, the balance sheet reduction is getting phased out, to end completely later this year: We apologize for upsetting the markets! The balance sheet reductions responsible for such actions will themselves be reduced.

To directly quote the Fed again, this time from Wednesday's prepared statement: “The labor market remains strong but...economic activity has slowed...job gains have been solid...the unemployment rate has remained low...overall inflation has declined...longer-term inflation expectations are little changed.”

And the translation: “We’re sorry! We promise to stop making the markets upset. No more rate hikes and we’re stopping this balance sheet reduction that y’all don’t like...but we’re still doing a good job” (read that last bit real petulantly).

The Fed isn’t the only one to flip-flop recently. The ECB also went from “unwinding” its balance sheet to moar quantitative easing (QE). MOAR!

As recently as December, there was a kind of global central bank choreography going on with policy normalization, but that choreography has been officially Left Sharked now. This is your new normal: a 2.5% fed funds rate (until they start cutting again), a $4T balance sheet, sub-2% inflation and sub-2% growth. Yippee skippy.The immediate response in the markets has been to buy everything, because the Fed has full-on signaled that they will prop up markets as much as possible. Both stocks and bonds ripped higher (for two days anyway...today has been a bit of a rough session for stocks).

But, the philosoraptor asks, if the Fed sees slowing economic growth (and enough slowing to pretty much completely flip-flop in three months), wouldn’t that be bad for stocks? Well yes, yes it would.Fun fact: the Fed has actually eased (lowered rates) through the last two market crashes. While the markets continued to crash. Remember that yield curve inversion recession indicator we wrote about last month? Well, it flipped today, for the first time since 2007. On average, that means a recession is 311 days out. Mark your calendars for Jan 27, 2020!

The jury is still out on what narrative will coalesce around the Fed actions - an appropriate response flip to economic conditions and an admirable restraint that will enable continued positive (albeit slow) growth, or the first action in response to a slowing economy and forthcoming recessionary flop. Depending on your viewpoint, you’ll either want to position your portfolio for Marshawn Lynch to run it in from the 1 or have Malcolm Butler jump the in-route. And, much like the Fed, you’ll probably do your own fair bit of flip-flopping between the two. Flip-flops roll downhill, as the saying goes. Or something like that. ​​

]]>Sun, 10 Mar 2019 05:00:00 GMThttp://www.atiwealthpartners.com/blog/taxesHappy tax month! Except for a couple accountant friends on the island, tax season is generally a giant pain. But once they’re done, most people are thrilled to receive a tax refund - who doesn’t like free money, right? Consider the flip side of that coin, if you will: a tax refund really means that you loaned your money to the government last year at zero percent. Actually zero, too, not the 0.01% “zero” your checking account earns. If you owe taxes, you got an interest-free loan from the government last year. No credit check necessary! At a high level, here’s how taxes work: Start with gross income; subtract “above the line” deductions to get “adjusted gross income”; subtract “below the line” deductions to get “taxable income”; look up your tax in the tax tables; compare to how much you actually paid during the course of the year; done.If you want a detailed list of all possible deductions, start with Wikipedia. Then hit the IRS website, but have a hefty supply of your favorite caffeine source handy. This article is not going to tell you why planting trees in your backyard won’t qualify for the reforestation expense deduction. But it will give you a few broadly applicable suggestions to reduce future years’ tax bills.

1)Increase your Traditional 401(k)/IRA contributionContributions to a Traditional 401(k) or a Traditional IRA are tax deferred, meaning you pay no tax now but will at some point in the future when you withdraw the money (as opposed to a Roth, where you pay now instead of at withdrawal). If you’re not maxing out your retirement contribution ($19,000 in a 401(k), $6,000 in an IRA for 2019) and have some excess savings lying around, consider bumping up that contribution to reduce your taxable income.2) Max out medical savings contributionsThere are three types of medical savings accounts: FSAs (flexible spending accounts), HSAs (health savings accounts), and Archer MSAs (medical savings accounts). Contributions are deductible or funded with pre-tax money to begin with - either way, it reduces your tax bill. Even better, as long as the funds are used on qualified medical expenses, what you spend is never taxed. Never. So go ahead and max out these contributions, unless it’s to an FSA - be careful with FSAs, that money doesn’t roll over like HSAs and MSAs, which means you could lose it if you contribute more than you spend.3) TimingWhen doing taxes, you either take the standard deduction (a set amount) or you itemize your deductions. The new tax bill bumped the standard deduction for a single filer to $12,000 from $6,350, meaning that it’s less likely you will benefit from itemizing. But! Say you’re sitting at $10,000 in itemizable deductions come December and you give $3,000 per year to various charities. Why not use a year-end bonus to give next year’s $3,000 charitable donations this year? That way you get to deduct $13,000 this year from itemizing and $12,000 next year (the standard deduction), saving yourself $1,000 in taxable income.So there you go. Reduce taxable income in future years by contributing to Traditional retirement plans and medical savings accounts. Take a look at your itemized deductions around Thanksgiving - if you’re close to the standard deduction, see if there is anything from next year you can bring forward into December to get over that itemization threshold. But for now, breathe a sigh of relief that it’s over, and go enjoy your tax day freebies on the 15th.​

]]>Wed, 20 Feb 2019 05:00:00 GMThttp://www.atiwealthpartners.com/blog/the-5-ws-of-recessionsThe number one macroeconomic question this year seems to be: When is the next recession? Or some variant thereof, like “What is going to cause the next recession” or “Are we in a recession” or “How do you prepare for a recession” or “My god, the yield curve is inverted! That means recession!” or “My god, look how close the yield curve is to inverting (depending on which part of the curve you look at), that means recession!”.

Economists are notoriously good at predicting recessions. They have accurately predicted 17 of the last 10. Plus, it’s a lot more fun to predict a massive recession than to say “menh, we’ll probably have 2% growth again this year” - it gets a lot more play in the press. Kind of like how earthquakes in California warrant more excitement (because it might fall into the ocean) than earthquakes in Oklahoma, despite the fact that there have been over 2,500 magnitude 3.0 or greater earthquakes in the last five years. Boomer Sooner indeed. Or how the Yellowstone volcano is more exciting than the 24 currently erupting volcanoes in the world, simply because it would destroy half the US.

So this month we’ll take a brief look at recessions in the US and see what we can glean about the next one.

What

Webster’s quite unhelpfully defines recession rather tautologically as the act of receding, so we’ll scrap the dictionary for this one. In economic terms, a recession is defined as two consecutive quarters of negative GDP growth. Going to back to the Great Depression, there have been 14 recessions in the US in the last hundred years or so; roughly one every 7 years if you like meaningless averages. We’re currently 10 years in to an economic expansion (read: no recession) and only a few months away from our longest ever non-recession streak. That means we’re overdue, right? Well, maybe. As an interesting data point, Australia has gone 27 years - and counting! - since their last recession.

The term “recession” then got slightly appropriated and slapped on to the end of other things that can go negative for two quarters, like an “earnings recession” or a “balance sheet recession” or a “Tesla production recession” or a “Netflix subscribers recession”. We may have made those last two up, but you get the idea. At a certain point it gets a bit silly and hyperbolic. Like when the weather channel starts hyping the next storm as the worst one since last month.

If you’ll recall from the valuation newsletters, stock prices are basically earnings times some multiple. In a recession, two things tend to happen: first, earnings will go down, causing stock prices to drop, and second, the multiple will also decline (for various reasons), causing stock prices to drop further.

Who

Because of the interconnectedness of the global economy, most of the attention is focused on the US. There’s not much good going on in global stock markets if the US dips into a recession. As the second largest global economy, China is also a concern, though there are lots of issues with getting accurate data out of China. “Europe” is also lumped together as a single entity, though the issues of concern there that make it across to our side of the pond tend to be more political than economic in nature (namely, Brexit or a future breakup of the EU). Italy is currently in a recession, but that hasn’t stopped Europe from being up almost 10% so far this year.

When

The problem with recessions is that you can’t identify them until you are well into one. The first official estimate of GDP for the fourth quarter last year is coming out later this week. Yes, first, as in there are multiple. Yes, estimate, as in GDP is a bit of dodgy number in and of itself. Consensus has Q4 GDP growth coming in at 2.5% or so, though the range of estimates is about 1.4% to 3%. In other words, all over the board.

Theoretically, imagine something happened back in October that drastically slowed economic productivity. A sudden trade war escalation. The imposition of a massive corporate tax hike. A balanced Federal budget. Whatever. But let’s say that Q4 GDP growth was actually negative. We would get our first official notice of that negative growth basically in March of the following year, 5 months later. Let’s further assume that said October something persisted and Q1 GDP growth was also on track to be negative. That would constitute a recession - two quarters (6 months) of negative GDP growth - and you don’t even find out that the first quarter’s growth was negative until you’re already in month 5 of 6!

That’s why people are so obsessed with forecasting recessions, because seeing into the future as a general rule tends to be more of an advantage than seeing into the now. Knowing, you could say, is half the battle. Unfortunately, this desire for knowledge tends to lend itself very quickly to crystal ball seers and snake oil salesmen (we’ll expand on that analogy in April’s letter).

Where

People look for recession indicators in all sorts of places. Jobless claims, various industrial/production/manufacturing indices...even completely esoteric indicators that backfit a trendline over a limited sample size. But the holy grail of recession indicators is the yield curve spread.

In a functioning economy, the interest rate on a 10-year bond should be higher than the interest rate on a 2-year bond. The difference between those rates is called the spread. If the spread is negative, that means that 2-year bonds yield more than 10-year bonds. This “inversion” has called every recession in the last 50 years (typically with a 19-month lead time, but who cares about details). We aren’t currently inverted on a 2s-10s basis at the moment (only 0.16 away!), but we are inverted in that 6-mo rates and 1-year rates are higher than the 2-year rates, and the 2-year is higher than the 3-year and 5-year rates. Which leads to things like this:

"Look at that 2s-10s trend closer each successive recession was preceded by a shallower and shallower inversion. The 2s-10s inversion was yesterday's recession indicator, what really matters is the overall percentage of possible yield curve spreads that are actually inverted at any given time! New and improved 2x concentrated recession indicator!"

Data doesn’t lie, but it’s incredibly easy to manipulate data into supporting a conclusion that is not true. Some of this has a legit economic basis and can be helpful in analyzing potential future risk/return profiles of investments, but a lot of it tends to be tea leaves and fear-mongering. As the Fantastic Mr. Box said - All models are wrong, but some are useful.

Alright, that was only 4 W’s...the “why” is all over the place, could be nearly anything, and would be complete conjecture at this point. Here’s the takeaway: media loves hyperbole, and the financial media is no exception. But in investing, being early is the same as being wrong. So we’ll look at the data as it comes in and respond as events warrant; however, against the current backdrop of doom and gloom, stocks have gone up for 9 weeks in a row and counting. No need to head for the hills just yet, though it probably doesn’t hurt to have a bag packed. Just in case.

]]>Sun, 10 Feb 2019 05:00:00 GMThttp://www.atiwealthpartners.com/blog/marchMaaaaaarghch. We got nothin’. Monosyllabic. Not punny. The only thing mildly related is “March of Dimes”, and that has been well taken already. So without further ado, let’s continue our 2019 series in content, if not title.

You’re paying yourself first

Your emergency fund has three months’ expenses in it

You are now here.

“Here” looks like different things to different people. For some people, “here” might be increasing that emergency fund to 6 or even 12 months’ expenses. Nothing wrong with that, but you know what you’re doing now, so keep at it and revisit this article when you’re happy with your emergency fund.

For others, “here” is about making your money work for you, which usually boils down to a question of which takes priority: saving/investing or paying down debt? The answer is, like so many other things, it depends on your personal predilections.

It’s not uncommon to see some best-selling personal finance gurus advocating some kind of zero-debt strategy. Like, pay off all your debt (including your mortgage!) before saving any money, or buy a house with cash only, or never use a credit card and only use debit cards…that kind of thing. That’s a very conservative option that is guaranteed to keep you out of trouble and may be the best bet for some people. But we tend to disagree.

Debt is not in and of itself the devil, as some would have you believe. Debt can be good. Debt can be productive. Debt can absolutely get you in massive, massive trouble, too. But so can a lot of things. Fun fact: all the money that you have in your bank account is considered a debt to the bank that has it. They take those deposits and use them to make loans, and they get a higher rate of interest on their loans (assets) than they pay you for your deposits (debts). That’s how banks make money.

That’s also how the vast majority of companies in the world grow. They take on debt and (ideally) use the money to invest in productive assets that return more than the cost of the debt. There’s no reason you can’t do the same thing.

For example: take out a home equity line of credit to remodel your kitchen before selling your house. That home equity line is debt, it charges you interest. But the expectation is that you will make more by improving your kitchen than you will pay in interest, so it makes sense. It’s the same idea with your money more broadly.

Let’s say you can get 8% returns by investing your money in the stock market. If you’re paying 18% interest on a credit card balance, by all means pay off the credit card balance! But if you’re paying 2% on a car loan, you’re better off not paying off that debt more quickly and instead investing the extra money.

What about a mortgage at 4%? Well, that’s where the personal preference comes in. From a strict numbers standpoint, 8% is greater than 4%, so you’re net positive if you don’t pay down the mortgage and instead invest the money. But stock market returns aren’t guaranteed and that 4% is, and owning your house free and clear is definitely worth something...but just how much is up to you and will vary person to person. Hence, it depends.

Want some help figuring out the best way to pay down debt while also working towards your other financial goals? Drop me a line at russ@atiwealthpartners.com and we’ll find some time to get together.